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department
of economics
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institute of
technology
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Cambridge, mass. 02139
J
THE METAMORPHOSIS OF GIANTS:
CHINA AND INDIA IN TRANSITION
Richard S. Eckaus
95-22
March 1995
MASSACHUSETTS INSTITUTE
fie Tcrwwrv DGY
1 4 1995
Liari/M-utS
95-22
THE METAMORPHOSIS OF GIANTS; CHINA AND INDIA IN TRANSITION 1
Richard S. Eckaus 2
Ford International Professor of Economics
Department of Economics
M.I.T.
March 20, 1995
I.
Introduction
Three great economic transformations are taking place now in
the world: in China, in India and in Eastern Europe and the for-
mer Soviet Union.
importance.
These three transformations are of enormous
China and India alone have about 40 per cent of the
population of the world.
The countries of Eastern Europe and the
former Soviet Union add almost another 10 per cent.
So the eco-
nomic fate of roughly half of the world's population is at stake
in the changes that are underway.
The changes are intellectually
exciting, as well as intrinsically significant.
As we watch
China, India and the former Soviet Union move toward freer market
economies, we will learn more about what is essential and what is
idiosyncratic about established market economies and how economic
and social systems change.
The transformations in process in China and India present
many puzzles and paradoxes.
While there is no single, overarch-
ing theory that will explain all of these, examination of the
pieces of the pieces of the puzzles will provide some insights.
For this purpose an even dozen of the influences on developments
in the two countries will be scrutinized.
Some occasional com-
parisons will be made to the former Soviet Union.
II.
The Setting
At the end of World War II and after the revolution in China
and achievement of independence in India these countries broke
their old patterns of stagnation and set out on new paths of eco-
nomic growth.
A comparison of the economic experiences of the
first thirty or forty years in the two countries is difficult,
because of their very different economic systems, intellectual
traditions and approaches to economic statistics.
Relying on the
opinions of experts, among whom there is some disagreement, it
appears that in the early 1950' s both countries were at about the
same per capita income levels. 3
Subsequently, the economic
growth in both countries was a distinctive and remarkable break
with the past.
In the 1960's, despite the differences in their systems and
in the economic fluctuations they had experienced, the Chinese
and Indian average per capita incomes were still not so far
apart.
According to the best estimates that try to take into ac-
count the different domestic purchasing powers of the separate
currencies the Chinese per capita gross domestic product in the
early 1960's was even slightly lower than that of India. 4
At the
end of the 1960's neither country had achieved the kind of eco-
nomic breakthrough that had already started to occur in the
rapidly industrializing countries of Asia, the four tigers of
Hong Kong, Korea, Taiwan and Singapore.
India's economic growth
actually slowed down in the late 1960's, while China's growth ac-
celerated and, by 1970, the Chinese per capita gross domestic
product was distinctly higher than that of India.
Subsequently
the Cultural Revolution caused a major slowdown in China,
the Indian economy also grew sluggishly through most of the
But
1970' s at, roughly,
3
per cent overall, in real terms, or about
1
per cent per capita, what one prominent Indian economist called,
"the Hindu growth rate."
In 1978 China started on a extraordinary economic advance
that has continued to the present with only brief slowdowns in
1985 and 1989-90.
1981,
From 1978 to 1993, the average annual
growth rate of real GDP was 9.4 per cent.
In 1992, the overall
growth rate reached 12.5 per cent; for 1993 it has been estimated
at over 13 per cent and the pace seems to have been almost
maintained in 1994.
It is difficult to convey how extraordinary
the growth record of these recent years is.
There are few coun-
tries that have ever achieved growth rates over 10 per cent per
year, even in the periods of their most rapid development.
In India, on the other hand, from 1980 to 1990, the average
rate of growth of real GDP was about 4.5 per cent, with oc-
casional accelerations during the late 1980* s to the
range.
5
per cent
In 1991 India faced a severe macroeconomic and balance of
payment crisis that forced a retrenchment from which it recovered
only slowly.
That has reduced the average annual growth rate
since 1989 to about
4
per cent.
Thus, China definitely moved to
a new growth trajectory in the late 1970' s and accelerated in the
1990 's, whereas India has fallen far behind.
Some skepticism about these comparisons is warranted, be-
cause there may be significant mistakes in the data on which they
are based.
For example, it is quite possible that part of agri-
cultural output was not reported before the "household responsibility" system was created in China.
Underreporting would make
it possible for the villages to retain more of their output for
their own use.
5
The incentive was removed when households were
allowed to retain their output in excess of their delivery quota.
The area of greatest suspicion is in the treatment of price
changes.
The rate of inflation in China has been quite substan-
tial in the last 15 years or so and there have been drastic
changes in relative prices.
Both types of changes are difficult
to treat accurately, in the best of circumstances.
By comparison, we know a great deal about the manner in
which the Indian national income accounts are constructed, but
there may be errors there too.
There is almost general agreement
that in India, as well as China, there is a significant un-
derground economy that is simply not measured.
Failure to take
account of its growth might explain some of the reported rela-
tively slow growth of the Indian economy.
III.
Explanations of the Relative Success of the Chinese and
Indian Economic Reforms
Three categories of reasons will be examined for the differences in the economic performance of China and India: first, a
few aspects of each country's particular combination of history
and institutions, second, resource availabilities and tech-
nologies, and, third, economic policy.
Since social and economic
influences interact, the hypotheses to be presented do not all
fall neatly into one or another of these categories.
For exam-
ple, there are underlying causes for differences in investment
patterns and the use of technologies.
Although the proximate
cause may be in some policy that has been adopted, the adoption
of the policy,
(
1)
itself requires an explanation.
The history and culture of China has made it particularly
receptive to market capitalism.
One of the most commonly voiced hypotheses for the relative
success of the economic reforms in China ascribes that success to
its special culture and social character. 6
The Chinese are often
described as essentially "capitalist" in character, natural merchants, who have in their basic character the qualities of capi-
talist entrepreneurship: to seek out economic opportunities, to
buy and sell and calculate profit margins.
The characterization is reminiscent of arguments of the
1950' s, when it was common to reverse the hypothesis for develop-
ing countries as a whole.
The lack of capitalist entrepreneur-
ship was then widely regarded as the most difficult obstacle that
developing countries had to overcome. 7
Many Ph.D. dissertations
were written then about the scarcity of entrepreneurship in de-
veloping countries.
One of the lessons of development of the
last thirty years is that lack of entrepreneurship is for the
most part associated with lack of opportunities.
In general,
when people are given education and economic opportunities, they
take advantage of both.
The Bengalis, the Gujeratis, the
Maharatis, and so on of India do not need lessons in entrepreneurship.
Interestingly, national character and culture are also some-
times used as an explanation of why economic reforms in the for-
mer Soviet Union have moved relatively slowly.
The argument is
that there never was much of a culture of entrepreneurship and
wage labor in Czarist Russia and that the 75 years of communism
have destroyed whatever there was.
The explanation overlooks the
history of the successful peasant kulaks and aggressive Russian
merchants and industrialists, who took advantage of the commercial opportunities that emerged in Russia in the late nineteenth
and early twentieth centuries. 8
(2)
The Indian bureaucracy has obstructed and the Chinese
bureaucracy has supported the economic reforms
The next conjecture about the reason for the relatively fast
pace of the Chinese economy is that the Chinese bureaucracy and
Communist Party structure have supported, while the Indian
bureaucracy and many of the political insiders have opposed their
economic reforms.
In the former Soviet Union the bureaucracies
and old politicos, the nomenklatura
opposition to market reforms.
.
have also generally been in
In all three countries, the eco-
nomic reforms have their origin and need the support from the
government sector.
So the unofficial as well as official pos-
tures of the government are important, if not crucial, factors.
At the time of independence, the Indian bureaucracy was
widely regarded both as honest and as one of the most effective
in the world.
Indeed, the persistence of the system of extensive
economic regulations may have, in large part, been due to the unusual ability of its bureaucracy to make its cumbersome system of
economic regulations work at least moderately well.
However, it
is now widely believed, both within and outside of India,
that
the bureaucracy has been corrupted by the system it regulated,
selling to the private sector many of the privileges created by
the regulations. 9
India, in fact,
is often regarded as the
paradigm of the "rent-seeking" economy in which private firms
devote substantial resources to pursuing the "rents", that are
the special economic returns from the particular privileges cre-
ated by extensive regulation.
If the rents are,
in fact,
impor-
tant, then it is likely that the pay-offs to the bureaucracy and
political insiders have also been important.
10
In the former Soviet Union the nomenklatura did not benefit
from the system it controlled by selling privileges in a market
economy, but it did profit from its special position.
The
dachas, the special summer resorts, access to the restricted food
shops, advancements for their children, and so on were important
privileges.
The government bureaucracy and the Party members in China
also enjoyed some special privileges, before the market reforms,
but their circumstances were, nonetheless, rather different.
The
beginning of the economic reform period came quickly after the
end of the tumultuous period of the Cultural Revolution and after
the reversal of many policies and personnel appointments.
Thus,
whether because of relative honesty, greater disillusion or a
shorter period within which to consolidate their privileges, the
Chinese bureaucracy had fewer commitments to the old regime of
government economic controls.
Reforms that eliminate government controls also eliminate
the rents that the bureaucracy can appropriate from distributing
benefits.
Such reforms even destroy the rationale for much of
the bureaucracy that administered the regulatory system.
So the
reforms attack the very raison de entre' of many of the
bureaucrats.
It is, therefore, understandable that the Indian
bureaucracy would oppose such reforms.
Likewise, market reforms
and the associated political reforms in the former Soviet Union
have also eliminated the rationale for much of the bureaucracy
and threaten the privileges of the old politicos.
Although
market reforms threaten some parts of the Chinese bureaucracy,
because of fewer prior commitments, the Chinese bureaucracy has
been more easily corrupted by the market forces that have been
unleashed.
11
That has converted them into supporters of the
reforms and high speed growth. 12
(3)
The fast growth in China is largely the result of the elimi-
nation of the gross inefficiencies of the previous system
.
There is, no doubt, some truth in the argument that at least
the initial successes of the reforms in China were, to a large
extent, the result of the elimination of some of the large and
pervasive prior mistakes and inefficiencies.
The enormous suc-
cess of the initial reform in agriculture is, perhaps, the prime
example.
In 1978,
in order to help a particularly poor region,
the authorities in a single province began the experiment of sub-
stituting individual household responsibility for collective production.
Incentives were created by allowing households to keep
their surplus output, which stimulated subseguent, very large
creases in production.
in-
With the approval and support of the cen-
tral government, the reform was copied throughout Chinese agriculture.
There are many other examples in China of rapid success in
making up obvious deficiencies.
Under the Communist planning
regime the Chinese economy, like the economies of the former
Soviet Bloc, was starved for many ordinary services, from clo-
thing and house repair to retail shops.
The provision of these
services does not require much capital and the skills are often
easily available.
So,
after the reforms made increased produc-
tion of services possible, the expansion of this sector has been
fast and relatively easy and has filled an major void in the
economy.
Yet, although there is certainly some truth to the
argument that China has moved fast by removing some of the most
flagrant obstacles to economic efficiency, that does not explain
the continuing fast growth over a number of years.
Changes of
this type are once-and-for-all and do not explain the continuing
fast growth over a number of years.
10
By comparison, India has always had a great deal of scope
for private initiative in agriculture, in services and other sectors.
So there are fewer opportunities for quick gains, particu-
larly in the private sector.
none.
That is not to say that there are
There are still major inefficiencies created by the
remaining regulations and in the state enterprises that could be
eliminated by further reforms.
(4)
The economic expansion in China is, to a large extent, due
to the boom in China in cooperative enterprises created and
managed at the local level.
The expansion of small scale, cooperative township and village enterprises (TVE's)
in China has been one of the most aston-
ishing features of its economic reform.
The real gross output of
these enterprises grew at the astounding rate of
year from 1985 to 1992.
3
per cent per
There is no counterpart to this ex-
plosive growth in India.
The success of the TVE's has been credited to their com-
munity support and participation. 13
Yet they have often been
heavily taxed and the benefits accruing to participants have not
always been spread widely through their communities.
Indeed, the
taxation has been a major source of difficulty for some TVE's, as
their revenues have been utilized in some communities as an im-
portant supplement to local taxation.
On the demand side, a plausible explanation for the TVE
phenomenon is that they have simply moved into the vacuum created
11
by the inefficiencies and limited scope of the state enterprises.
They are providing goods and services that have been inadeguately
supplied or completely neglected in centrally planned economies.
On the supply side, part of the explanation for the remarkable
success of the TVE's is the prior, widespread distribution in
rural areas of small scale handicraft and industrial skills.
While the Great Leap Forward was an enormous human disaster, it
nonetheless left
a
residue of such experience.
It is also pos-
sible that the pre-reform concentration on heavy industry and the
inadeguacies of the transport system had stimulated local depen-
dence on small scale production that provided a basis for subseguent, post-reform expansion.
The absence of a comparable fluorescence of small industry
in India in response to its reforms may be explained in two ways.
First, there was a rapid expansion of the Indian private sector
in the 1950' s and 1960 *s, as new firms filled gaps created by new
opportunities.
We may now be seeing in China the analogue of
that early Indian experience.
Second, the Chinese small scale
TVE experience may be a temporary phenomenon that the Indian
economy has passed by.
Although there is evidence that labor
productivity in the TVE's has risen rapidly, there can be little
doubt that a small TVE cement plant producing a few tons a day is
simply not as efficient as a large plant would be.
The TVE ce-
ment plant may do well at first because of production bottlenecks
and inefficiencies in the larger state operated plants and in the
s
12
transport system.
Yet, because there are undeniable economies of
scale in cement production, the small plants will not be able to
compete with plants of efficient scale.
other types of manufacturing.
The same will be true in
It is, therefore, an open question
as to whether the TVE's will survive,
if either the large state
enterprises or converted into efficient establishments, or as
firms grow and consolidate.
(5)
The simplest and best explanations of the differences in the
economic performance of China and India are the higher
savings rates and higher capital productivity in China.
Turning from culture and institutions to the relatively
simple matter of the amount of resources devoted to growth, the
most obvious first explanation of the high Chinese growth rates
is in its high overall savings rates.
These rates had already
been relatively high, at about 30 per cent until the late 1970'
when they begin to rise to forty per cent in the 190* s.
The In-
dian savings rates have also increased, but more recently and
much more modestly from around 20 per cent in the 1980' s to the
range of 23 or 24 per cent.
To help put the extraordinary
Chinese savings rates in perspective, the savings rates of the
Japanese and Swiss, two of the thriftier peoples of the world are
34 and 30 per cent, respectively.
Small Singapore, an urban area
with a much higher per capita income, is the only non-oil exporting country that matches the Chinese savings rate.
High savings rates make it possible to have high investment
rates and those, in turn, make it possible to have high growth
13
Whether the possibilities are realized depends on the
rates.
productivity of the investment that the savings rates make posThe overall productivity of investment in China and India
sible.
seems to have been about the same for many years, but in the last
few years China has gained an advantage over India in this
respect.
Even a slight difference, compounded over time, can
generate big differences in wealth. 14
The improvement in the productivity of China's investment in
recent years is also unusual.
Development economists might well
have expected the reverse situation.
It has often been true that
there has been a kind of diminishing returns to the rate of investment, due to something called,
"limited absorptive capac-
But that limitation has not as yet been important in
ity."
China.
(6)
The higher levels of foreign investment in China than in
India are an important part of the explanation of the
differences in their performance.
Foreign funds supported a much smaller share of investment
in China than in India for most of the period since the end of
World War II.
From the beginning of the Chinese economic
reforms, private foreign investment in China has grown rapidly
and became more important than in India.
It is difficult to be
precise about relative magnitudes due to lags in reporting, differences in the details reported and the differences between com-
mitments and actual investments. 15
According to World Bank data,
14
however, long term capital inflows to China in 1993 were US$
billion, while for India they were US$ 10 billion.
3 3
Foreign in-
vestment in India has started to increase in the last two years
and it is possible that a fundamental change in past patterns may
be beginning.
It is something of a puzzle as to why foreign investors have
preferred China to India.
Although Indian politics is as un-
settled as in many democracies, Indian democracy has survived
many challenges and remained strong.
By comparison, to many ob-
servers the future course of the Chinese political system seems
relatively unclear, so political uncertainties that influence
economic calculations would seem to be less important in India.
India has firmly established and relatively familiar legal system, with protection of private property rights and clear,
if
restrictive rules for the payment, hiring and firing of labor.
The Indian tax system is also well defined and, although rates
may change, there will be no great surprises.
By comparison, the
protection of property rights and contracts in China and its tax
regime are still evolving and there have been unfavorable surprises.
16
The Indian financial system is more extensive and more
experienced than that of China, which is still rudimentary.
In-
dia has more engineers than any other country and has the ad-
vantage of wide use of English in the work force, whose average
wages are as low as in China.
All this and yet foreign investors
have been relatively reluctant to invest in India as compared to
China.
15
There are several components to the explanation of the
puzzle.
First, success breeds success.
than India.
China is growing faster
Still, the Indian market is more than large enough
to be attractive to foreign investors,
policy was receptive.
if only Indian economic
But it has not been consistently so.
China now offers rapid clearances for foreign investment, prefer-
ential tax rates, duty free imports for exported goods, guarantees for profit and royalty repatriation, and special permissions
to dismiss labor.
Until recently in India it has been a long and
tedious process to obtain government approvals for foreign investment.
It is now reported that procedures have been reformed
and approvals go through in fifteen days or less in "deregulated"
areas, with few rejections.
quite broad.
But the regulated areas are still
Moreover, there is a well-known recent case of a
major U.S. firm being hounded out of an approved investment by an
outcry raised in Parliament.
On the one hand, the Indian govern-
ment has announced the opening of oil exploration and mineral
prospecting and mining to private, including foreign investors.
On the other hand, Indian parliament members promise to drive
the,
"advance guard of American capitalism,"
Pepsi, out of India.
17
Coca-Cola and
So the prospects for foreign investment
in India may still appear somewhat unsettled.
The commitments by the Chinese emigre' populations in Hong
Kong, Taiwan and Singapore help explain the relatively large pri-
vate investments in China.
Though these are sometimes explained
16
by their special attachment to their origins of the Chinese
living abroad, as compared to emigrants from other countries,
personal or family knowledge of conditions in China and command
of the language is a simple alternative explanation.
(7)
Economic reform has been a clearer and more definite
commitment in China than in India.
This is one more paradox in the comparison of China and India.
Private enterprise and cooperative endeavors in pursuit of
profit were anathema in China for many years.
So an absolutely
firm government commitment to reform policy seems to be essential
an essential requirement to induce both domestic and foreign pri-
vate or cooperative enterprises to undertake investments.
Yet,
given the opacity of the political system, it would appear to be
difficult for an outsider to be completely convinced of this commitment.
Moreover, there have been occasional slowdowns, if not
reversals, in the movement toward a market economy and occasional
inconsistent public statements.
The political uncertainties are reflected in the stories
about the decisive role in China of the Communist Party elders
and the obscure competition for leadership among the next generation.
The effects of that political process on the final shape
of economic reform policy are uncertain.
If these concerns are
taken seriously, and there is no other way for outsiders to take
them, the political climate in China would seem to provide a
dubious basis for long term plans.
17
Yet that does not seem to be the case.
Rather, the commit-
ment to economic reform has been regarded by foreign investors as
firmer in China than in India.
That might be explained by the
fact that in India the current reforms are being put in place by
a
minority government.
That might as well be interpreted as evi-
dence of general support, since the reforms could be relatively
easily blocked by a determined opposition, but it could also be
interpreted as evidence of the tenuous political basis of the
reform program.
It is often pointed out that the time span of the Chinese
reform program, which started in 1978, is much longer than that
of the Indian reforms.
It is true that, until 1991, the steps
toward reform in India were small and tentative.
On the other
hand, the transformations in India, although of great sig-
nificance, are certainly less wrenching than the policy reversals
in China.
Perhaps it is the openness and vehemence of the
political debate in India that explains the paradox.
(8)
In China much of the decision making with respect to reforms
has been decentralized and many of the reforms have originated at
the regional and local level.
In India the reforms have
originated and been propelled by central government actions,
often with local government resistance.
This is still another somewhat paradoxical difference.
It
is only partially resolved by the realization that control of the
Chinese economy has not been highly centralized in Beijing for
18
many years.
Immediately after their successful revolution, the
Chinese Communists were instructed by and emulated the centralized Soviet system in their approach to the direction of their
economy.
This tutelage was shrugged off as the result of Mao Tse
Tung's distrust of the Soviet Union and, as well, of concentrated
bureaucratic control.
Another consequence of this distrust was
the devolution of economic power from Beijing to the provincial
governments in a series of policy moves beginning in the late
1950' s.
There were partial reversals in this devolution at vari-
ous times, but, by 1978, the provinces held a great deal of eco-
nomic power, including the power to undertake major innovations.
The Chinese provincial authorities have been extraordinarily
eager to introduce market reforms, appearing to try to outdo each
other in this respect.
planation.
Three conjectures will be offered in ex-
The first is that the transfer of power to the pro-
vinces that started not long after the Chinese revolution has
generated both a feeling of confidence and the reality of competence in the local governments.
The second reason is that some
of the important steps in the market reforms,
in particular, the
household responsibility system in agriculture, originated in the
provinces.
The special economic zones, administered by provin-
cial authorities are also one of the great successes of the
reform program.
So the provincial authorities could, in effect,
claim to be the chosen instruments of reform.
Finally, the suc-
cess of the provincial economies leads to higher tax collections
19
and greater independence from the central government in Beijing
in carrying out local projects.
By comparison, the Indian states have had less scope for in-
dividual action.
The Indian system, for example, has not allowed
the states to set their own rules for investment, either domestic
or foreign.
So the initiatives had to come from the center.
Moreover, although it is beginning to change, there are a number
of states with governments with histories of ideological opposi-
tion to market capitalism that have not made the Chinese transition.
In addition, political opposition and communal hostility
in states that might have been expected to be growth leaders,
such as the Punjab, have created uncertainties that have dis-
tracted potential economic reform movements.
(9)
The reforms have been piecemeal in both China and India,
rather than a "shock" treatment, but China has experimented with
a wider range.
Both China and India have adopted a kind of "installment
payment" approach to reform, rather than an economic "shock
treatment."
The step-wise process of reform in China is partly a
consequence of the local origins of many of the reforms, but it
is also part of the overall strategy of Chinese reform, which has
been pragmatic and experimental.
China has consciously adopted
the pattern of trying out particular types of market reforms in
restricted areas and then abandoning or generalizing them,
depending on their success.
The special economic zones, the lo-
20
cal stock markets, the free trade areas, the opening of specific
sectors to foreign collaboration and, perhaps, most importantly,
step-wise deregulation of prices, are all examples.
The "dual track" price system, that was adopted with the
intention that it evolve into a single price system, as, in fact,
has been happening, is an important aspect of China's incremental
approach.
A set of official prices was maintained for many com-
modities, including many of the goods produced by state enterprises, at the same time as market determination of prices was
allowed for some share of the same commodities, and other prices
were set completely free.
Although it is important that an economy be guided by real
scarcity prices, it is also true that there are major adjustment
costs in moving to such prices and that these costs can endanger
the success of the transition process.
The dual price system
created the potential for diversion of goods from one market to
another, with consequent inefficiency in resource allocation and
creation of opportunities for corruption, but it also lessened
those stresses, as the range of price decontrol was slowly extended.
"Muddling through" in China has not eliminated the in-
efficiencies and deficits of the public enterprises, but it has
reduced their significance.
It can be argued that this only
delays the necessary adjustment to more efficient methods of pro-
duction and distribution, but there are also other constraints
21
that have delayed the transition.
So the slow price adjustment
may not mattered very much.
The reform process in India has also been an incremental
one,
for some analogous and some different reasons.
Although In-
dian reforms may be thought of as being simply a broadening of
the scope of existing markets, they also require painful adjustments.
Because of the openness of its political processes, we
can also see the political forces that line up against economic
reform more clearly.
These include protected domestic enter-
prises as well as ideological opponents to market capitalism and
both bureaucrats and labor unions who fear the loss of protected
markets and special benefits.
The tenuous Parliamentary majority
of this Indian government is the best explanation of its slow
movement, but it is plausible that this would be true of any
government in a democracy, except one elected by a landslide to
do the reforming, which is certainly not the case in India.
The relatively slow pace of reform in India reflects divisions in the country with respect to economic liberalization, one
aspect of which is the growth of individual and regional income
inequalities.
change."
That has produced the slogan of, "continuity with
In India this has been interpreted as,
There are similar slogans in
*go slow."
China, however their meaning seems
to be some nostalgic commitment to the past.
They certainly do
not mean, "go slow."
Price reform is also important in India.
Subsidized prices
in the large public sector establishments have often been used to
22
subsidize particular regions and sectors of the economy.
Price
regulation in agricultures has distorted farmers incentives.
But
India also has a large private sector in which some prices have
been determined by market forces.
Although it has preserved in-
efficiencies, by moving deliberately, the Indian government has
largely avoided the public anger and bitterness that rapid change
has evoked in the former Soviet Union.
(10)
Neither China nor India have made significant progress in
privatizing their public enterprise, but China may have been more
successful than has India in increasing their efficiency.
Public enterprises in both China and India suffer from
endemic inefficiency.
That,
in turn, has created a need for sub-
sidies that are a major drain on the government budgets.
In both
countries the governments have announced intentions for extensive
privatization, but in neither country have the intentions been
followed by actions that have been very effective in reducing the
subsidies.
In China,
in the "enterprise responsibility system", the
output targets of state enterprises have been transformed into
profit targets.
The precise level of the targets are, appar-
ently, the result of a kind of bargaining process between minis-
try representative and the officials of each public enterprise.
Higher wages, bonuses and access to investment funds are the
"carrots" which the ministry representatives use to induce better
management.
It is difficult to know what "sticks" may be applied
23
in the bargaining process.
The Chinese procedure is clearly open
to abuse and, at best, is far from the incentives of a free
market.
Yet it has been partially successful in creating pres-
sures for increased efficiency, though not enough to substantially reduce the burden of subsidies.
18
In India, most public enterprises have been converted into
corporations which, nominally, have considerable independence in
seeking to maximize their profits.
In many cases a minority
fraction of the total equity has been sold into private hands.
Though partially successful, as in China, it has not led to general improvements in efficiency,
,
as shown by the continuing low
profits or substantial losses of the enterprises. 19
(11)
The willingness and ability of the Chinese and India
governments to control inflation continues to be tested with
India currently showing more success.
Macroeconomic policy is a critical ingredient in the
catalysis of economic growth and both China and India have been
quite sensitive in this sphere of action.
The bursts of ebul-
lience of the Chinese economy after the start of the reform pro-
gram has led to successive balance of payments problems and in-
flationary pressures.
There have been four such episodes from
1978 to the present: in 1981, 1985, 1988-9 and currently.
Each
episode, up to the present has been followed by rigorous remedial
deflationary policies.
In the first three cases, the deflation
was effective and the recovery and resumption of rapid growth was
24
quick. 20
The current episode of inflation may be dated as start-
ing in 1992 and has lasted longer and been more severe than the
previous episodes.
The inflation rate in 1994 is now officially
reported to have been 22 per cent, with a high of 27.7 per cent
in October,
1994.
Early in 1993, as inflationary pressures became obvious, Zhu
Rongji, formerly mayor of Shanghai, was appointed as vice premier
and given the task of controlling these pressures.
was, presumably,
This decision
influenced by the experience of the Tiananmen
Square protest in 1989, which was widely regarded as a partial
consequence of inadequate control and inequitable adjustment to
inflationary pressures.
Zhu's appointment.
A number of important actions followed
These included the reorganization of the cen-
tral bank and establishment of effective control over the provincial branches.
In the past, the credit facilities of the provin-
cial banks have expanded under the pressure of local government
and political officials, helping to provide the monetary base for
the inflationary pressures.
The provincial bank control measure
was supplemented by a State Council order halting major new in-
vestments in fixed assets, presumably because it was believed
that credit policy would not, by itself, be effective. The new
tax laws inaugurated at the end of last year also give the central government increased powers to deal with inflation.
The limitations on credit to state enterprises in July of
last year were reported to have been abandoned after several
"
25
months of complaints.
In early November of last year Deng Xiao
Ping was guoted as saying that, "Development at a slow pace is
not socialism."
Zhu Rongji was reported at that time to have,
"faded from view." 21
controlling inflation.
Yet he continues to be guoted in support of
At the end of January, the State Council
was reported to have "reissued" its ban on new investments in
fixed assets, implying, first, that the ban issued in July of
1993 had not been fully effective and, second, a renewed
determination to control inflation.
Announcements of the exten-
sions of the ban were repeated through 1994 and limitations on
state enterprise credits have been reimposed.
The different interests in Chinese official circles with
respect to the rate of economic expansion help explain the conflicting signals with respect to the Chinese government's commit-
ment to fighting inflation.
As an indication of the internal
debate, there have been accusations that the Chinese Politburo
had kept from the public the remarks by Deng Xiao Ping encouraging more rapid economic development.
This was done, it was al-
leged, because of fears that the remarks would,
"exacerbate divi-
sions within the party and contradictions between the center and
the regions
.
22
The side in favor of slowing the economy to dampen inflation
appears to be led by Zhu Rongji, but behind him are those party
and government officials who were powerful enough to put him in
place.
Although apparently not in the Rongji circle, Prime Min-
26
ister Li Peng, supported vigorous action against inflation in his
speech to the National People's Congress in March, 1995, which
also made a veiled criticism of the responsible parties who had
not successfully controlled inflation.
Outsiders cannot know how
to count the votes on this issue or even if there are votes.
This is a critical moment in the Chinese reform program.
Apart from the political consequences, the lessons of history
tell us that excessive inflation can become a major obstacle to
real development.
is hard to say,
What constitutes "excessiveness" in inflation
since there are countries that have managed
sustained growth with inflation rates of 20 per cent or more.
These countries have evolved ways of adjusting to inflation that
do not now exist in China.
By comparison, over most of the past twenty years India's
record in limiting inflation has been more consistent than that
of China, with price increases averaging around
year until 1990.
7
per cent per
In that year inflation was slightly over 10 per
cent and reached almost 14 per cent in 1991, before falling to 10
per cent again in 1992 and to about
8
per cent in 1993.
The recognition of a balance of payments and inflation
crisis in 1990 and 1991 brought the present government into power
and provided the immediate rationale for structural reforms as
well as changes in macroeconomic policy.
Yet, the political
weakness of the government has limited its ability to adopt un-
popular deflationary policies.
27
The IMF agreement, under which India has operated for the
last several years, is an official commitment to reduce inflation, with the IMF watchdogs watching closely.
There has been
considerable success in reducing the balance of payments deficits
since 1990, when the current account deficit was over
of the gross domestic product.
3
per cent
A sharp devaluation of the rupee
and changes in foreign exchange policies to give greater incen-
tives to exports has stimulated exports and reduced imports.
In
the past year the balance of payments deficit has been reduced to
one sixth of the 1990 value.
The government budget deficits have
been reduced sharply and inflation rates have come down to about
seven per cent in early 1993 before moving up again to ten per
cent in late 1994.
(12)
The growth in China relative to that in India and the former
Soviet Union is due to China's choice of "perestroika" before
"qlasnost"
.
i.e..
economic decontrol before greater political
latitude?
This proposition reflects one of the great issues of social
policy, debated with respect to China and India, debated in the
former Soviet Union, debated with respect to many of the developing countries of the world.
It is,
for example, a favorite theme
of the former prime minister of Singapore, Lee Kuan Yew, who is
apparently credible because of the economic success of Singapore.
He frequently argues that democracy and the transition to suc-
cessful economic development are not compatible, that economic
28
transformation must come before political liberalization. 23
Yet,
the experiences of China and India furnish little illumination on
this grand question.
They are just two sets of observations and
the list of other factors that have contributed to the dif-
ferences in their economic success is a long one.
Before taking up the proposition, it will be useful to deal
briefly with one other, related matter.
Without diminishing the
real concerns about civil liberties in China, it cannot be denied
that there is now much more personal freedom in China than before
the economic reforms started.
It remains circumscribed and at-
tacks on the political system are still suppressed, although more
in some regions than in others.
In most other respects the scope
for freedom of choice and behavior has expanded greatly and not
just in what might be called the tokenism of dress codes.
Thus,
it cannot be maintained that the economic reforms in China have
proceeded against a background of unchanged and unrelenting suppression of individual liberties.
Was it necessary for its economic success for China to allow
more personal freedom and will further economic success make a
successful transition to wider political freedoms more likely?
It has been argued that the policies that reduced the interdic-
tions in personal behavior and introduced the economic reforms
were a reaction to the constrictions and convulsions of the Cultural Revolution. 24
A plausible case can also be made that the
expansion of personal freedoms was essential to make the economic
29
reforms effective.
Peasants might not have responded so posi-
tively to the household responsibility system, if they could not
have used their additional income to build better housing, eat
better food and wear better clothing, none of which was assured
during the darkest days of the Cultural Revolution.
After those
oppotunities come personal radios, television, the migration of
their children to cities and the beginnings of changes in lifestyles.
It might also be argued that the entrepreneurial freedom
that has generated the efflorescence of the TVE's and private enterprise, often with foreign participation, could hardly be con-
fined to the business world.
As to whether the economic reforms
will lead to more political freedom, that goes beyond the experience that has been observed and history does not provide a sure
guide.
What does Indian development tell us on this question?
Rather little.
India became a democracy with independence and
has never placed itself in a position in which a choice had to be
made between openness and economic development.
The institutions
of Indian democracy have been strengthened by time and severe
tests.
The current reform government, which is relatively weak,
in terms of its parliamentary margins, took power after an assas-
sination that might be interpreted as creating political uncertainty, but that uncertainty was not about the continuation of
democracy in India.
It is this weak government which is carrying
out the reforms that stronger governments could or would not.
30
This, undoubtedly is to some degree responsible for the careful
pace at which the reforms have been introduced.
The Indian expe-
rience does tell us, first, that democracy does not insure rapid
growth and, second, that, in the perplexing way that democracies
sometimes work, weak governments can become the instrument of
strong reforms.
The following is true: economic liberalization of a rigidly
regulated system, although it benefits everyone, on the average,
will hurt some people and create uncertainty among a great many.
Thus,
in order to carry it out successfully, the people must be-
lieve in the government's promises and the government must be le-
gitimate in this sense.
For different reasons that has been the
case in both China and India.
While the Tiananmen Square events
were said by some at the time to have destroyed to the legitimacy
of the Chinese government, that has not been the case in the
sense that its people have become inert or uncooperative or have
stopped participating willingly in the reform programs. 25
IV.
Postscript
It is too early for a final judgment on the relative contri-
bution of all of the elements in the reform programs in China and
India and, for China, there may never be enough data to permit a
reasonably firm conclusion.
There are also still major, though
different obstacles to overcome in each country before economic
victory can be declared.
In China the transformation of the eco-
nomic system has far to go and many problems remain to be dealt
31
with,
for example: the inefficiency of the public enterprises,
the entanglement of household consumption decisions with employment,
for example in the provision of housing, the need for a
comprehensive banking system and the provision of set of laws
that detail property rights.
Although the transformation in India not so profound, it too
is a major reshaping of the economy.
There are ingrained habits
of xxx inherited from colonialism that have never been purged
from the bureaucracy.
There are fierce disagreements over cen-
tral elements in a reform program, such as the protection of
scheduled caste privileges and the extension of important public
responsibilities, such as compulsory education.
India, too, has
to convert its public enterprises and change its labor laws, its
price controls and production regulations.
There is too much to summarize and the discussion above warrants no general conclusions, but, rather a reprise: the changes
underway in China and India are singular events.
They are
momentous and intellectually fascinating and deserve continuing
careful attention, for themselves and for what they may reveal
about the essence of market economies.
.
.
32
The XIII Eckstein Memorial Lecture, Center for Chinese
1
Studies, The University of Michigan
I have benefited from the scholarship of many others, who,
2
of course, have no responsibility for the manner in which I interpreted their work. On the reforms in China, in addition to
other works cited below, I should mention the work of A. Husain
(1992), Yingyi Qian and Chenggang Xu (1993), and Zhiyuan
Cui,(1993).
There is less published material available on the
Indian economic reforms, but the analysis of J. Bhagwati and T.N.
Srinavasan (1993) and the Indian Ministry of Finance have been
particularly helpful. I am also indebted to the excellent assistance of Christiana Stamoulis in elucidating some of the data.
3
See Subramanian Swamy,
4
See R. Summers and A. Heston,
(1979)
.
(1991)
During the Great Leap Forward, the pressures to appear to
5
be achieving Mao's quite unrealistic goals led to reporting of
output gains just as a severe drought was drastically reducing
output.
This contributed to the devastating famine of the late
1960's.
6
See,
for example, K. Chen, et__al, 1992, p. 216.
7
See,
for example, B. Higgins,
8
(1959)
Chap.
13.
See A. Gerschenkron (1951)
There are no surveys of bureaucratic practice to support or
invalidate this view. It is simply the stuff of countless
stories of dealing with the government.
9
A.O. Krueger (1974), p. 294.
There are incessant official campaigns against government
corruption. Reformers outside the Party and the government have
also made this an issue. The capital punishments imposed are officially justified in terms of the dangers to social stability
and the success of the economic reforms created by corruption.
12
Although these characterizations of the Chinese and Indian
bureaucracies are pervasive, there is also general agreement that
there are many persons of dedication and integrity in both systems, as, presumably, there were in the former Soviet Union.
10
11
13
See M.L. Weitzman and Chenggang Xu, 1993.
Modigliani and Cao (1994) calculate that the large decline
in public savings in China since 1978 has been offset by a
similarly large increase in private savings. The latter increase, they argue, has ben stimulated by the rapid growth rates,
which leaves a chicken and egg problem.
15
India does not officially report direct foreign investment.
14
33
16
The government decision in late 1994 to evict the McDonald's
restaurent from its prize location near Tiananmen Square, in
spite of a long term lease is a notorious example of such a "surprise"
Indian Parliament member as quoted in the Boston Sunday
17
Globe
.
.
18
See T.G. Rawski,
19
See J. Bhagwati and T.N. Srinavasan (1993), pp. 47-53.
20
See, R.I. McKinnon,
21
Wall Street Journal
22
Reported in the China News Digest
(1993).
(1993).
.
Nov.
23,
p.
D6.
.
March 5,1994.
Actually Lee Kuan Yew's proposition is one about transi23
tions of countries from colonial, military or single party rule
that are much less ideological and oppressive than the unreformed
communist systems of the Soviet Union and China.
A.D.Barnett (1981), pp. 27-33
24
25
Another interpretation is that the Tiananmen Square
protests were not against the reforms themselves, but rather
against some perceived inequities in their administration.
.
34
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